The ECB proposes a swift solution for SMEs’ financing

The European Central Bank is deeply worried about the ability of Eurozone’s SMEs to access bank financing at a reasonable cost and under competitive terms. The present business loan stalemate has already bitten into the growth prospects of the euro area, mirrored in the dangerous fall of inflation rate towards the deflation zone and the anemic growth rate oscillating just above zero. On many occasions Mario Draghi, President of the ECB, has focused on the negative answers the SMEs receive on their bank loan inquiries and their impact on Eurozone’s growth prospects. As everybody knows, Eurozone banks are currently in a precarious situation facing the quality asset review and the stress tests of the central bank. The last thing the lenders now want is to load more SME loans on their balance sheets, especially in south Eurozone countries where such loans are badly needed. Unfortunately for the SMEs, their only possibility of financing is one or more loans from the lenders. Small businesses cannot float share or bond issues in capital markets. The south bank countries In this way Italian, Spanish and Greek SMEs are suffocated, deprived of the possibility their counterparts in core Eurozone countries amply enjoy. The astonishing thing is that for the same business risks, the SMEs in the south can’t find financing, an option amply offered in Germany and other core member states. This dualism cannot be accepted by the ECB, which is mandated to make sure that its monetary policy is transmitted to every corner of Eurozone. Presently, the ECB offers liquidity to all Eurozone banks at almost zero interest rates, but only the core countries can fully profit from this possibility. The lenders in the south remain under stress by the mounting ‘repudiated loans’ in their balance sheets, in the aftermath of the credit crisis. This is a recession trap though. The banks cannot cope fast with their ‘red loans’ and as a result they cannot finance the much-needed recovery of the SMEs. This leads to a new cycle of recession. Difficulties in securing financing and higher interest rate cost in an environment of falling prices, make things difficult for banks and drive the SMEs to extinction. An existential question for SMEs Given that 99.7% of firms in the EU are SMEs, this is an existential question to be answered. This said, it becomes clear that the fortunes of the euro area economy are intertwined with the financial health of SMEs. If the decision makers prove unable to find an answer to this problem, it’s more than certain that sooner or later Eurozone will drift to negative inflation, with a generalised and demoralizing fall of all prices. In view of all that, it was the turn of Yves Mersch, a Member of the Executive Board of the ECB to take the lead in trying to break the financial dead-end of Eurozone SMEs. To this effect, he delivered an inspired speech at the Deutsche Boerse – Clearstream ‘Exchange of Ideas’ event, in London. The title of his discourse was ‘Overcoming the current challenges faced by small firms’. The theme was how policy makers can facilitate the match, between investors and SMEs through the securitization of business loans by banks. Securitisation of SMEs’ loans He observed that, “So we have a situation where certain banks own assets with risks and capital charges that they do not wish to bear. On the other side, there are investors who are willing to bear those risks. In my view, this is a match that should happen in an efficient financial system, and securitisation of SME loans is the way to achieve it. What is more, the funds received by banks from transferring bundled SME loans to outside investors can help support new lending, also to SMEs, and in turn support further securitization”. In his speech, Mersch adequately addressed the question of how to overcome the increased risk element associated with securitizing MSEs’ loans. For one thing, he pointed to the tightened of the financial rules in the EU. He said “For example, since 2011 EU lenders are required to retain a share of the resulting asset backed securities (ABS), which motivates them to securitise better quality assets. Furthermore, the Capital Requirement Regulation requires that originators apply the same underwriting criteria to loans which are securitised as those applied to loans that remain on the balance sheet. In addition, measures such as the recently-adopted Mortgage Credit Directive will improve underwriting standards across the EU…So we see that the worry about underlying asset quality is likely to be confined to a number of increasingly-verifiable cases”. It can be done He then proceeded to offering solid data on Eurozone’s ABSs excellent performance. He pointed that “Given these asset pool and structural safeguards, it is not surprising that there have been very few European ABSs’ defaults. Depending on the study and starting date, since the start of the 2007/08 financial crisis defaults range between 0.6-1.5% on average, against 9.3-18.4% on average for US securitisations. What is more, European SME ABSs are far below both broader EU and US securitisation default rates, with defaults occurring on about 0.1% of instruments. And, even more convincingly, our internal analysis suggests that ABSs eligible for Eurosystem operations have historically had impairment rates even lower than non-eligible ABSs. This suggests again that sensible asset and structural safeguards can go a long way to mitigating the risks of investing in ABSs”. He then concluded that “It is not too late to change course: not all EU securitisations deserve the stigma attached to them for the past few years. There is a need to restore coherence across financial sectors in particular amid the unfavourable regulatory treatment of (high quality) securitisation instruments without violating prudential principles. By doing so we must act fast and in a manner that is sensitive to our own European reality. If the Bank of England and the ECB were to put forward a joint statement on this issue at the forthcoming IMF Spring Meetings, it would underline the European determination to decisively move forward”.   In short, if the ECB and the Bank of England have started talking about such a prospect, the day the SMEs return as a growth engine of Eurozone, might not be far away.